Module 2 Assignment. Short-Answer and Algebraic Questions: (The numbers in square brackets give the breakdown of the points for various parts of each question. To receive full credit, please explain your answers.)
- This question is based on the article, “China’s vanished current-account surplus will change the world economy,” published by The Economist on May 17, 2018. For your convenience, the article is copied below. The article reports that China’s current account balance, which had been positive and typically large between 2004 and 2017, turned negative in the first quarter of 2018. It then explores the reasons for this change.It should be kept in mind that the article does not mention the balance in unilateral transfers because it is negligible in the case of China.
(a) Based on the discussion and the data presented in the article, what were the trends in China’s balance of trade in goods between 2011 and 2018? [16]
(b) Based on the discussion and the data presented in the article, what were the trends in China’sbalance of trade in services between 2011 and 2018? What factor is likely to have been the main driver of those trends? [17]
(c) Does the data presented in the article indicate a clear trend in China’s factor income balance between 2011 and 2018? Has that balance been on average positive or negative during those years? [17]
(d) Based on the data presented in the article, was the sharp drop in the current balance in the first quarter of 2018mainly due to a drop in the services trade balance,the goods trade balance, or some other component? [10]
(e) According to the article, China’s current account balance has declined in 2016-2018, when compared to 2014-2015. What does this tell us about the trend in the savings rate in China between those two periods? How can one deduce this trend from the data and discussions in the article despite the absence of consistent data on savings? [25]
(f) The article points out that “if China’s current-account deficits become more frequent, it will have to run down its foreign assets or borrow more from abroad.” Why is this the case? What is the relationship of current account balance with the changes in a country’s foreign asset (official reserves) holdings and its borrowing abroad (non-reserve assets) transactions?[15]
Disappearing trick
China’s vanished current-account surplus will change the world economy
The yuan will become more volatile, but also start to rival the dollar
Print edition | Finance and economics
May 17th 2018| SHANGHAI
NOT long ago China was a leading culprit in global economic imbalances. Whether blame was ascribed to its undervalued yuan or its frugal people, the problem seemed clear. China was selling a lot abroad and buying too little back. One data-point summed this up: its currentaccount surplus reached 10% of GDP in 2007, well above the level that is generally seen as reasonable. Far less attention has been paid to its steady decline since then. In the first quarter of 2018 China ran a current-account deficit, its first since joining the World Trade Organisation in 2001. Just as its massive surpluses of yore had big consequences for the global economy, so does this swing in the opposite direction.
China still exports many more goods than it imports, to the tune of nearly $500bn annually. But its share of global exports appears to have peaked. At the same time its trade deficit in services is getting bigger, largely thanks to all its tourists venturing abroad (see chart).
At bottom, a current-account balance is the difference between a country’s investment and savings. When China had a big surplus, its savings, at 50% of GDP, far outstripped even its colossal investment. Data on savings are patchy in China. But it is known that investment has declined as a share of GDP. The implication is that the rate of savings has almost certainly declined more sharply, reflecting a big increase in consumption. Its economy is, in other words, better balanced than just a short while ago.
China’s current-account deficit in the first quarter was exaggerated, since exports tend to be subdued at the start of the year. It is likely to return to a surplus in the coming months. But Ding Shuang of Standard Chartered, an emerging-markets bank, forecasts that the surplus will be just 1% of GDP this year and 0.5% next year. The trade ruckus with America could reinforce the downward trend. To placate President Donald Trump, China will try to import more from America and pay more for foreign intellectual property (IP), Mr Ding says.
One probable outcome is that the exchange rate will become more volatile. In recent years capital outflows have pressed down on the yuan, but the current-account surplus has countered that effect. In the future China will have a thinner cushion. Depending on quarterly trade swings, the yuan will be as likely to fall as to rise.
If China’s current-account deficits become more frequent, it will have to run down its foreign assets or borrow more from abroad to pay for its consumption. Should its external liabilities—that is, money it owes the rest of the world—increase rapidly, that might signal greater financial vulnerability. But as long as the increase is moderate, it could actually help China by boosting the yuan’s global profile.
To fund its deficit, China might choose to sell more bonds to foreign investors. And in paying more for goods and services than it earns, it could supply its currency abroad. By itself this would not be enough to make the yuan go global. Investors would need more faith in China’s institutions. But technically, the conditions would be ripe for the yuan’s emergence as a more credible rival to the dollar. America might find itself pining for the days when the Chinese currency was undervalued.